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Beware the bubble fixes of Greenspan era

TOSHIHIKO Fukui is looking more and more like Asia’s answer to Alan Greenspan.

It’s exactly what many Japanese politicians had hoped for. When Mr Fukui became Bank of Japan (BOJ) governor in March 2003, lawmakers urged him to be the ‘Greenspan of Japan, if not Asia’. It was a bow to the then Federal Reserve chairman’s effect on markets and the power of his monetary policies.

Politicians got their wish – just not in the way many imagined. Now, markets are paying the price for Mr Greenspan’s mark on Japan’s rate policies. Mr Fukui’s BOJ, just like Mr Greenspan’s Fed, has both created and enabled bubbles overseas with ultra-low rates.

All this may come as a surprise to Mr Fukui’s supporters, and there are many. To them, he restored the credibility they felt had been lost during the 1998-2003 tenure of Mr Masaru Hayami. The adulation sometimes seems akin to how many view Mr Greenspan, who was dubbed ‘Maestro’ in a gushing 2001 book by Bob Woodward.

What’s conveniently overlooked about Mr Greenspan’s 1987-2006 tenure is his role in China’s asset bubble and, by extension, Asia’s. His policy of keeping interest rates unusually low in the first half of this decade fuelled speculation in high-risk assets. That led to a cheap-capital-fuelled investment bubble in China.

Mr Greenspan’s culpability for the financial contagion that the US sub-prime-mortgage mess is sending Asia’s way is almost beside the point. The first hint that Mr Greenspan’s fingerprints were on this crisis came in June when former Fed colleague Edward Gramlich told the Wall Street Journal that Mr Greenspan had opposed a proposal that would have boosted oversight of sub-prime lenders.

Mr Greenspan seems to be getting a pass from a Wall Street that remembers kindly how he bailed out investments time and time again. From the Mexican peso woes and the financial meltdown in Orange county, California, in the mid-1990s to Long-Term Capital Management’s collapse in 1998 to the Internet stock bubble of the late 1990s, Mr Greenspan proved to be a reliable market saviour.

That’s the Fed’s job, some might say. And Mr Greenspan’s genius, supporters say, rested in the very reason Woodward dubbed him Maestro: his ability to conduct all instruments of economics amid an orchestra of political demands.

More often than not, though, that meant helping Wall Street traders out of a jam. One side effect is what economists call the ‘bubble fix’, whereby central bankers’ attempts to calm markets lead to economic imbalances. Mr Greenspan’s time at the Fed featured more than a few such episodes.

Will Mr Ben Bernanke’s? It’s an open question following the Fed’s Aug 17 move to cut the discount rate – which it charges banks – by 0.5 percentage point to 5.75 per cent. The surprise reduction was aimed at containing the sub-prime collapse, which threatens the broader credit markets.

Significantly, the Fed didn’t lower the more potent federal funds rate. Slashing the rate banks charge each other for overnight loans would have had a more dramatic impact on markets – and on perceptions of Mr Bernanke’s betrothal to them.

Given that barely two weeks earlier the Fed was fretting about inflation, his move, while clearly forced by markets, was a savvy one. The trouble begins if he starts slashing more vital rates at the next policy meeting on Sept 18. Mortgage lenders did dodgy things; the Fed doesn’t have to save them from facing the consequences with a bubble fix.

By the time the Greenspan Fed began raising rates in mid-2004, it was already too late for Asia. Like clockwork, once the Fed lowered the federal funds rate to 1 per cent, speculative capital flows rushed to Asia.

In 2003, flows destined for Asia topped the previous peak in 1996, just before the region’s crisis began.

The biggest recipient, of course, has been China. Not surprisingly, Asia’s No. 2 economy is home to any number of speculative bubbles, from property to stocks.

Low US rates complemented zero rates in Japan. Today, as the BOJ begins a two-day policy meeting, the odds are extremely low that Mr Fukui will boost rates from 0.5 per cent. That may be a green light to investors to continue borrowing cheaply in yen and moving those funds overseas into riskier assets. The so-called yencarry trade is feeding bubbles globally.

One way in which all that easy money manifested itself was by fuelling a surge in the use of derivatives. The search for higher returns boosted growth in the market for collateralised debt obligations. The upshot was untold amounts of leverage and risk in a global financial system struggling to keep up.

Globalisation means Fed policies play a bigger role in Asia than folks in Washington may realise. The Fed is responsible for the US economy, of course, and Mr Bernanke will focus on trends there. Asia will just have to hope his policies don’t overwhelm its markets with easy money.

Safely back in the private sector, Mr Greenspan is now among those warning of bubbles in China. It’s one thing for investors such as Marc Faber to do that; it’s another for Mr Greenspan to – unless he’s looking in the mirror. Instead of Maestro, ‘Mr Bubble’ may be a more accurate nickname.

Source: BLOOMBERG (The Straits Times 23 Aug 07)

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